June 18 (Bloomberg) -- The Federal Home Loan Banks jointly
agreed to a three-month moratorium on admitting captive
insurers, which are being used by mortgage investors to access
the government-chartered system, according to three people with
knowledge of the step.

The 12 FHLBs offered the move voluntarily in a letter to
their regulator, the Federal Housing Finance Agency, which has
voiced concern that the trend is adding risk to the system, said
the people, who asked not to be named because the talks are
private. Captive insurers largely serve the needs of their
parents.

Lightly regulated investment firms and lenders that lack
customer deposits, known as shadow banks, are flocking to FHLBs
for dependable funding that often offers better terms than
traditional banks or debt markets. The new memberships are
drawing scrutiny from the FHFA because they may affect the
safety of a system that operates with $786 billion of debt seen
by investors and credit raters as being backed by taxpayers.

The freeze may slow a boom in admissions after Redwood
Trust Inc. last week said its captive insurer obtained
membership in the Chicago FHLB. Redwood became the fourth real-estate investment trust focused on mortgage investments to join
the network of regional lending cooperatives since October.

Annaly Joins

Annaly Capital Management Inc., Invesco Mortgage Capital
Inc. and Two Harbors Investment Corp. also have insurance units
that have become members.

Angie Richards, a spokeswoman for the Des Moines FHLB, and
Jeff Sanders, a spokesman for the Home Loan Bank in
Indianapolis, declined to comment. Melissa Warden, a spokeswoman
for the Chicago FHLB, didn’t immediately respond to an e-mail
seeking comment. The three FHLBs are the ones that have admitted
units of REITs.

Peter E. Garuccio, an FHFA spokesman, declined to
immediately comment on the moratorium. He said last week in an
e-mail that the overseer plans “to address the issue of
captives.”

The FHLB system was set up in 1932 after a string of bank
failures caused by runs on deposits, and has accepted insurers
since its start. Members buy stock in the institutions and get
access to low-cost, wholesale funding in return for pledging
collateral such as mortgages.

While mortgage REITs’ insurance units are overseen by state
regulators, the financial health of their parent companies
aren’t the responsibility of any U.S. agencies.

Illicit Perception

“Captive insurance borrowing and membership in the FHLBank
system raises a number of possible issues related to safety and
soundness and access to the system,” FHFA head Melvin Watt said
in a speech at a conference for FHLB directors in May. “You
will certainly be hearing more about this as we move forward.”

In reality, “we do not see material risk, believe there
are more than adequate checks and balances in place” and view
the REITs as contributing to the system’s public policy
objectives, Widner said. “Nevertheless, the political nature of
the issue adds uncertainty to how it will develop.”